The first research projectOur hypothesis maintains that financial services organisations generally implemented performance and risk management process (specifically operational risk processes) as isolated, silo processes. Given that the data, processes, systems and ultimate ‘consumers’ for the management information from these processes are the same or very similar, we contend that organisations would benefit significantly from taking an integrated approach, as supported by the Risk-based performance methodology. Additionally we believe that taking a silo approach leads to significant reduction in the quality of management information and significant increase in related costs and risks.
This research project was undertaken between mid 2006 and mid 2007 and involved 21 executives from 19 UK based financial services organisation. There was a balance of different types of organisations and participants from different roles, including finance, risk management, operations and IT roles. Supporting the field research was extensive literature and case study research.
The question that this research set out to answer was: How should companies integrate the Balanced Scorecard and operational risk management to enhance strategic execution?
Secondary research objectives were;
1. To identify current performance management and operational risk management best practice through literature and industry research.
2. To test the applicability of the proposed Risk-based performance methodology as an approach to integration and alignment of Balanced Scorecard and operational risk management.
3. To identify likely benefits of integrating Balanced Scorecard and operational risk management processes, specifically with relation to strategic execution.
Headline findings
- Various studies suggest that strategic execution failure rates, failure to meet long-term budgets and goals, are estimated to be between 40 - 70%.
- Kaplan & Norton's assertion that “the real problem isn’t [bad strategy] but bad execution” is widely supported.
- The average initial cost of a major (greater than US$ 1 million) operational risk event is estimated at US$65 million.
- On average, the subsequent tail loss is 12 times that initial cost - a staggering US$780 million.
- Improving operational risk management processes to meet the Basel II AMA requirements can lead to an estimated 25% reduction in regulatory capital allocation.
- To date, whilst the industry is becoming increasingly competitive and regulated, it has generally taken a reactive approach to performance and risk management.
What is the problem?
With an estimated 40 - 70% of companies failing to execute their strategy and the average operational risk event (greater than US$1 million) initially costing an estimated US$65 million , with average tail losses estimated at US$780 million there is clearly a need for greater emphasis on performance and risk management processes. Particularly given half of the operational risk events are due to factors within the control of financial services organisations.
In seeking to address these issues, financial services organisations create duplication and waste by taking a silo approach to implementing the Balance Scorecard and operational risk management processes. This approach adds cost and complexity. While the processes involved take additional time to implement and manage whilst decreasing the quality and timeliness of the management information delivered.
Whilst the financial services industry faces increasing regulatory and competitive pressures, the research indicates that it's response is reactive and tactical rather than proactive and strategic. This is demonstrated in the study which found 12 out of 19 organisations were categorised as 'metric-focused', with only four categorised as 'execution-focused'.
The study also found the financial services industry was responding to regulation more readily than competitive pressures, with nine organisations demonstrating high or increasing levels of sophistication related to risk management, whereas surprisingly no organisations could be categorised as 'performance-focused'.
The research suggests a methodology such as Risk-based performance which breaks down the existing silo approach is key to integration and alignment, and enhancing strategic execution. To quote one of the interviewees, “I think your approach makes a lot of sense. The challenge in many organisations is they are operating [their BSC and ORM processes] in silos”.
What are the likely benefits of enhancing strategic execution via integration and alignment?The overwhelming conclusion from the research was there are significant benefits to be gained from enhancing strategic execution via the integration and alignment of Balanced Scorecard and operational risk management processes. These benefits include reducing the rates of strategic failure, (estimated at 40 - 70%); and reducing operational risk losses which, one expert argues offers greater potential savings than traditional cost cutting. Given the initial costs (estimated at US$65 million) and tail losses (estimated at US$780 million), and that approximately 50% of operational risk losses are within the control of organisations, clearly there is significant cost cutting potential. Improving risk management processes will also enable organisations to reduce regulatory capital by an estimated 25%.
Perhaps most importantly however, the main benefits are likely to come from developing the right Risk-based performance culture; one which understands the trade-offs between performance and risk. This culture would also be most effective when a crisis hits because of the depth of understanding related to performance and risk, and the pattern of robust discussion, decision-making and action-taking that will inevitably develop within executive and management teams.